A collection of observations, news and resources on the changing nature of innovation, technology, leadership, and other subjects.

January 26, 2016

Corporate Survival: Lessons from Biology

Having lived through IBM’s near-death experience in the early 1990s, respect for the forces of the marketplace is edged deep in my psyche.It’s frankly sobering how many once powerful IT companies are no longer around or are shadows of their former selves. The carnage might be more pronounced in the fast-changing IT industry, but no industry is immune. It would seem as if darwinian principles apply in business almost as much as they do in biology.

A few weeks ago I discussed a paper published last year, The Mortality of Companies, by physicist Geoffrey West and his collaborators at the Santa Fe Institute.Based on their extensive analysis of data about publicly traded US companies, they were surprised to discover that a typical firm lasts about ten years before it gets merged, acquired or liquidated, and that a firm’s mortality rate is independent of its age, how well established it is or what it does.While beyond the scope of their study, the authors speculated that biological ecosystems are likely to shed valuable insights into their findings.

“Some business thinkers have argued that companies are like biological species and have tried to extract business lessons from biology, with uneven success,” note the authors.“We stress that companies are identical to biological species in an important respect: Both are what’s known as complex adaptive systems.Therefore, the principles that confer robustness in these systems, whether natural or manmade, are directly applicable to business.”

After analyzing the longevity of more than 30,000 public US firms over a 50-year span, the authors found that companies are disappearing faster than ever before. “Public companies have a one in three chance of being delisted in the next five years, whether because of bankruptcy, liquidation, M&A, or other causes. That’s six times the delisting rate of companies 40 years ago. Although we may perceive corporations as enduring institutions, they now die, on average, at a younger age than their employees. And the rise in mortality applies regardless of size, age, or sector. Neither scale nor experience guards against an early demise.”

Complex systems, whether natural, social or engineered, are composed of many parts. But it’s not the mere number of component parts that makes them complex. After all, a stone or a table is composed of huge numbers of molecules, yet we would not consider them complex. A truly complex system consists of many different kinds of parts, intricate organizations and highly different structures at different levels of scale. Humans, bacteria, advanced microprocessors, modern airplanes, global enterprises, urban environments and national economies are all examples of complex systems exhibiting these massive, heterogeneous, intricate characteristics.

What makes such systems complex is not their basic functionality but their adaptability, that is, the various mechanisms that help the system evolve and survive in a changing environment.But these adaptive mechanisms will in turn render the system more complex.They often lead to unintended consequences such as new failure modes, which are then corrected over time with additional adaptive mechanisms, which then further add to the complexity of the system, and so on and on and on.

The HBR paper notes that “companies are dying younger because they are failing to adapt to the growing complexity of their environment.Many misread the environment, select the wrong approach to strategy, or fail to support a viable approach with the right behaviors and capabilities.”

Corporate mortality is further exacerbated by three broad trends: a more diverse, harsher and less predictable business environment; the faster pace of technological innovation which forces companies to adapt to new business cycles at about twice the rate as 30 years ago; and the increasing integration of business ecosystems and global markets, which while good for economic vitality, adds to the risks of system-wide shocks.

“In a complex adaptive system, local events and interactions among the agents, whether ants, trees, or people, can cascade and reshape the entire system - a property called emergence.The system’s new structure then influences the individual agents, resulting in further changes to the overall system. Thus the system continually evolves in hard-to-predict ways through a cycle of local interactions, emergence, and feedback…In business we see workers and management, through their local actions and interactions, shape the overall structure, behavior, and performance of a firm…Whether we look at team dynamics, the evolution of strategies, or the behavior of markets, the pattern of local interactions, emergence, and feedback is apparent.”

What does this mean for business leaders?Drawing on their research at the intersection of business, biology, and complex systems, the authors identify six key principles to help increase the robustness of complex business systems.

Maintain heterogeneity of people, ideas, and endeavors.Diversity is key to evolutionary adaptation in biology.Similarly, diversity increases the flexibility of business systems, helping them adapt to unpredictable changes from within or outside their industry that might obsolete their business models.While diversity might decrease short-term efficiency, it’s absolutely essential for a company’s survival in the longer term.

Diversity is necessary, but not sufficient.A commitment to innovation is essential.While It may not always help the business stay out of serious trouble, anticipating major changes and understanding its various options will help the company adapt to new market realities. Doing so effectively requires the kind of leadership that will attract and retain the best possible talent and create a culture of innovation that encourages them to come up with creative solutions to the challenges the firm faces.

Sustain a modular structure of loosely connected components.The more integrated its components, the higher the risks that a shock in one part of the system will rapidly spread across to other parts.A modular adaptive system, that is, one consisting of more loosely connected components, is in a better position to resist the spread of shocks and make the overall system more robust.

But, there are trade-offs.Within a company, integration across business units or geographical regions can enhance information flows, efficiency gains, and innovation.So can integration with other business stakeholders in the broader ecosystem.However, such tighter interconnections also amplify risk, making the company vulnerable to adverse events.“Despite the trade-offs, modularity is a defining feature of robust systems. A bias against it for the sake of short-term gains carries long-term risks.”

Preserve redundancy among components.Over millions of years, biological organisms have developed redundant mechanisms to increase their chances of surviving disease or accidents.When one mechanism fails, another can step in.The immune system, for example, has developed multiple, overlapping lines of defense against pathogens of all sorts.

Companies often view redundancy as the antithesis of efficiency.But, as business systems become more complex, the interactions between their internal components and those of the environment in which they operate dominate the overall design.Serious problems and system-wide shocks can increasingly occur from the unanticipated interactions among these various components.Resiliency must be therefore built into the design of the system, including alternative mechanisms to keep the system operating despite accidents or shocks.A resilient company must make the proper trade-offs between efficiency and redundancy.

Expect surprise, but reduce uncertainty.Few things are harder to predict than the potential impact of new technologies, business models or market changes.Every company, no matter how large or small, should view itself as being but one asteroid away from trouble or oblivion, even more so now given our accelerated pace of change.But while the future is indeed unpredictable, we can continuously do the equivalent of scanning the sky to see if any asteroids might be heading our way.

Doing so requires talent and R&D investments. Talented people can generally anticipate disruptive changes years before they happen through their own research as well as their interactions with research communities, universities and startups.They can take preemptive actions against potential threats by developing alternative products and business strategies.

Create feedback loops and adaptive mechanisms.Natural selection is the process by which “traits that enhance survival and reproduction become more common in successive generations of a population.”Mutation is nature’s way of conducting many diverse experiments, and natural selection is the feedback mechanism used to amplify those traits most likely to survive.

Companies have traditionally relied on forecasting and planning to develop their long-term strategies.But such exercises are less relevant and reliable in a fast changing, unpredictable business world.They must instead embrace a more iterative innovation process based on marketplace experimentation, feedback loops and adaptive mechanisms, - the business equivalent of natural selection.

Mutual trust is also essential to the robustness of complex adaptive systems.The individual interests of a firm will often conflict with the interests of the overall business system.If enough individual firms pursue their own selfish interests, the overall system becomes weaker and everyone suffers.While seeking to maximize their own profits, leaders should consider how their firms are adding value and contributing to the overall business ecosystem.

“Rising corporate mortality is an increasing threat, and the forces driving it - the dynamism and complexity of the business environment - are likely to remain strong for the foreseeable future,” note the authors in conclusion… “Understanding the principles that confer robustness in complex systems can mean the difference between survival and extinction.”

Comments

You might also take a look at The Living Company by Aries de Gues. He was commissioned by Royal Dutch Petroleum to see whether any companies had survived 100 years. As I recall there were four characteristics of long lived companies: 1) a high degree of internal mutual trust 2) strong boundaries around the company -- hard to get in, but once you were in, you tended to stay 3) financial conservatism 4) tolerance for explorations at the boundaries of the current business. It's interesting to compare these to yours and also to how IBM at least used to be.

I am all for quantitative analysis, but I do think it needs to be tempered with humility. I think one major reasons companies fail in small ways and large is that they believe their models too deeply. So long as conditions do not change, the models work. If the conditions change, they do NOT have sufficient redundancy to survive. Trivial example: Someone determines a company can save a million dollars a year by making a wrapper with only a quarter inch of extra plastic. This is enough for 95% of the population to eventually open the container. However, at some point, the raw ingredients of the plastic are differently sourced or the containers are outsourced to a cheaper company whose quality control is not as good, or the demographics of the user changes, or 100 other things so that now there is only 1/8 inch of extra plastic which is only enough for 5% of the population to open the container. Larger example is reducing salesforce to the bare minimum. At first, people work overtime, become more efficient and all looks well. But meanwhile, the best people are applying for other jobs etc. A slight boom in the economy and suddenly half the best sales people are gone and it is very very hard to find and train new ones in time to meet the uptick in demand.